ProPublica, the fantastic non-profit journalism entity, has a new story out with NPR that is a doozy of financial scandal story:

Freddie Mac, the taxpayer-owned mortgage giant, has placed multibillion-dollar bets that pay off if homeowners stay trapped in expensive mortgages with interest rates well above current rates.

Freddie began increasing these bets dramatically in late 2010, the same time that the company was making it harder for homeowners to get out of such high-interest mortgages.

What makes this story particularly galling is the following:

Freddie Mac, along with its cousin Fannie Mae, was bailed out in 2008 and is now owned by taxpayers. The companies play a pivotal role in the mortgage business because they insure most home loans in the United States, making banks likelier to lend. The companies’ rules determine whether homeowners can get loans and on what terms.

In addition to being an instrument of government policy dedicated to making home loans more accessible, Freddie also has giant investment portfolios and could lose substantial amounts of money if too many borrowers refinance.

Hence, the seeming need to hedge their portfolio by placing bets against the very homeowners they're supposed to be supporting!

Freddie Mac's trades, while perfectly legal, came during a period when the company was supposed to be reducing its investment portfolio, according to the terms of its government takeover agreement. But these trades escalate the risk of its portfolio, because the securities Freddie has purchased are volatile and hard to sell, mortgage securities experts say.

"We were actually shocked they did this," says Scott Simon, who as the head of the giant bond fund PIMCO's mortgage-backed securities team is one of the world's biggest mortgage bond traders. "It seemed so out of line with their mission."

The trades "put them squarely against the homeowner," he says.

"More than three years into the government takeover, we have Freddie Mac pursuing highly levered, complicated transactions seemingly with the purpose of trading against homeowners," says Columbia University real-estate economist, Christopher Mayer. "These are the kinds of things that got us into trouble in the first place."

But why would they make these risky trades? Hmmm....could it be this?

Even though Freddie is a ward of the state, top executives are highly compensated. Peter Federico, who's in charge of the company's investment portfolio, made $2.5 million in 2010, and he had target compensation of $2.6 million for last year, when most of these leveraged investments were made.

Ring the bell! These executives are raking it in at the expense of homeowners trapped in high interest rate loans, who can't re-finance these loans at a lower rate because Freddie Mac won't let them!

It's disgusting and outrageous, although apparently The Fed tried to do something about this last year:

In a recent white paper on remedies for the stalled housing market, the Federal Reserve criticized Fannie and Freddie for the fees they have charged for refinancing. Such fees are "another possible reason for low rates of refinancing" and are "difficult to justify," the Fed wrote.

A former Freddie employee, who spoke on condition he not be named, was even blunter: "Generally, it makes no sense whatsoever" for Freddie "to restrict refinancing" from expensive loans to ones borrowers can more easily pay, since the company remains on the hook if homeowners default.

One last question would be: where's the government oversite?

The Federal Housing Finance Agency (FHFA) effectively serves as Freddie's board of directors and is ultimately responsible for Freddie's decisions. It is run by acting director Edward DeMarco, who cannot be fired by the president except in extraordinary circumstances.

The trades raise questions about the FHFA’s oversight of Fannie and Freddie. But the FHFA is not just a regulator. With the two companies in government conservatorship, the FHFA now plays the role of their board of directors and shareholders, responsible for the companies’ major decisions.

Under acting director DeMarco, the FHFA has emphasized that its main goal is to limit taxpayer losses by managing the two companies’ giant investment portfolios to make profits. To cover their previous losses and ongoing operations, Fannie and Freddie already had received $169 billion from taxpayers through the third quarter of last year.

The FHFA has frustrated the administration because the agency has made preserving the value of the companies’ investment portfolios a priority over helping homeowners in expensive mortgages. In 2010, President Barack Obama nominated a permanent replacement for acting director DeMarco, but Republicans in Congress blocked him. Obama has not nominated anyone else to replace DeMarco.

And why did the Republicans block his replacement? Hopefully we'll find out in the next installment.

In the meantime, check out the story for all the gory details on the trades Freddie Mac made. It's a pretty astonishing story, indeed.

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Tags: Fannie Mae, Federal Reserve, Freddie Mac, Obama

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The NY Times recently reported on the minutes released of meetings at the Federal Reserve back in 2006 on the eve of the massive housing crises that gave us The Great Recession. Read it and weep:

As the housing bubble entered its waning hours in 2006, top Federal Reserve officials marveled at the desperate antics of home builders seeking to lure buyers.

The officials laughed about the cars that builders were offering as signing bonuses, and about efforts to make empty homes look occupied. They joked about one builder who said that inventory was "rising through the roof."

But the officials, meeting every six weeks to discuss the health of the nation's economy, gave little credence to the possibility that the faltering housing market would weigh on the broader economy, according to transcripts that the Fed released Thursday. Instead they continued to tell one another throughout 2006 that the greatest danger was inflation -- the possibility that the economy would grow too fast.

"We think the fundamentals of the expansion going forward still look good," Timothy F. Geithner, then president of the Federal Reserve Bank of New York, told his colleagues when they gathered in Washington in December 2006.

Some officials, including Susan Bies, a Fed governor, suggested that a housing downturn actually could bolster the economy by redirecting money to other kinds of investments.

Yet the most egregious part of this story is that many of the same folks are still in positions of power and pontificating that all's well on the economic front. Hello, Tim Geithner!

Krugman's got something to say about this, as well:

Two puzzling things: first, the housing bubble was the clearest thing I've ever seen in my professional life. How could they ignore even the possibility of a severe bust?

Second, some of the same people you read in these transcripts dismissing risks to the real economy and worrying wrongly about inflation are still making policy pronouncements, in which they … dismiss risks to the real economy and worry wrongly about inflation.

You should be scared...very...very ...scared.

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Tags: federal reserve, Federal Reserve Bank of NY, Geithner

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